Puerto Rico Has Managed To Avoid Default….Sort Of

Puerto Rico had a $350 million bond payment due yesterday. Miraculously, Governor Alejandro Garcia Padilla managed to pull a rabbit out of his hat. The Governor is going to “clawback” or default on some debt “in an effort to attempt to repay bonds issued with the full faith and credit of the Commonwealth and secure sufficient resources to protect the life, health, safety and welfare of the people of Puerto Rico”.

“Today’s debt service payments reflect our commitment to honor our obligations notwithstanding the extreme fiscal challenges we face in an effort to facilitate a voluntary restructuring process with our creditors,” said Melba Acosta, the GDB president, in a news release. “However, make no mistake, Puerto Rico’s liquidity position is severely constrained at this time despite the extraordinary measures the Government has taken to improve it.” One of the many ideas on the table to deal with Puerto Rico’s massive $70 billion debt load is a so-called superbond.

In meetings with advisers to creditor groups in November, the government’s chief adviser, Jim Millstein, “presented a proposal to exchange the island’s existing bonds for new debt that would be less burdensome to Puerto Rico,” according to a report in the New York Times by Michael Corkery. “The proposal — at least in theory — was met favorably by holders of billions of dollars of general obligation bonds. However, the government still needs to win over many other creditors, making a deal far from certain.”

Make no mistake, the superbond would have some clear limitations. For one, hedge funds who hold a good portion of Puerto Rico’s debt have indicated that they may be willing to negotiate with the government by turning in their existing bonds in exchange for a superbond which would then be issued by the Government, according to the Times report. And what’s good for hedge funds could wind up being bad for Mom and Pop investors.

“Broadly speaking, the exchange would involve rolling up most of the island’s current debt and restructuring it into a new superbond,” according to the Times. “As part of that new bond, general obligation holders would have the first claim on government revenues, giving them the highest priority in the superbond structure. Holders of other forms of the government’s debt would have lower priority. It is not clear whether bondholders, in return, would be asked to buy into the superbond at a discount, rendering their investments less valuable than their current holdings.”

Although the Times doesn’t spell it out, the Puerto Rico superbond would likely be at a discount to the existing bonds, probably 15% or so. That would give the holders of the new superbonds 85% of their prior value. It is likely that the interest rate and duration will also be adjusted.

Investors in UBS Puerto Rico Bond Funds will likely be drawn into the overall debt restructuring if the hedge funds and mutual funds, which hold the majority of the debt, ultimately go along with the superbond proposal.

Senator Charles E. Grassley, the Republican chairman of the Senate Judiciary Committee, held a hearing on Puerto Rico’s inability to file for bankruptcy protection and reorganization under chapter 9, which is used by U.S. cities and local governments. The hearing will be one in a series of hearings intended to consider help for Puerto Rico.

So far Puerto Rico’s efforts to persuade Congress to pass legislation that would allow it to file bankruptcy for its public corporations, like sewer and water authorities, has fallen on deaf ears in a Republican controlled Congress. Will the Grassley hearing today be any different?

In the end, Puerto Rico’s fate may wind up with the superbond proposal. Will it leap tall buildings and save the day, like Superman did in the comic books, or will it turn out to be another dud? Stay tuned.

Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions. For more information about Zamansky LLC, please visit http://www.ubspuertoricofunds.com/.